Amendments to the UK Takeover Code - DLC Transactions and Break Fees

Originally published on October 4, 2002

So called dual-listed company or "DLC" structures have become newsworthy on both sides of the Atlantic as a result of the on-going rival Royal Caribbean/P&O Princess and Carnival/P&O Princess transactions.

A DLC structure is a means of achieving the economic effect of a merger between two publicly traded corporations without any acquisition of one by the other. Instead, the two companies retain their separate identities, their separate shareholders and their separate listings but operate as if under unified management, for example through having identical boards of directors, contractual equalisation arrangements to ensure equal dividends are paid and special voting arrangements which, in effect allow the shareholders of one company to vote at the meetings of the other.

P&O and Royal Caribbean agreed to enter a DLC arrangement, subject to a shareholder approval. They also agreed a joint venture arrangement which included a change of control provision which would trigger substantial penalties for P&O should it be acquired by a third party. Following the announcement of these transactions, Carnival Corporation launched a hostile bid for P&O which was conditional on termination of the joint venture.

At the time of the Royal Caribbean/P&O announcement, the UK City Code on Takeovers and Mergers did not apply to DLC transactions because the Code focused on the question of whether a transaction results in a change of voting control of the company (in this case P&O) which might otherwise be subject to the Code. This placed Carnival (and so P&O's shareholders argued, those shareholders) in a worse position than if the Royal Caribbean/P&O transaction had been subject to the Code. Had the Code applied:

• the penal effects of the change of control provision would have been limited to 1% of the value of P&O if it had been entered in connection with the DLC transaction; and
• Carnival would have been entitled to receive from P&O the same information as P&O had provided to Royal Caribbean.

P&O's shareholders, and the institutional shareholder community in general were unhappy with the situation created because the Code did not apply because the combined effect of the break fee and the conditionality of Carnival's offer was to prevent P&O shareholders comparing the rival proposals on an equal footing.

Takeover Panel Response
The UK Takeover Panel has responded by amending its rules, following consultation, to bring DLC transactions involving a UK public company within the scope of the Code. As a consequence, DLC transactions will be subject to the provisions of the Code with some modifications. In particular:

• the tighter rules governing disclosure of dealings in shares that apply during an offer will be relevant;
• the rule prohibiting subjective conditions will apply with the effect that a party seeking to invoke a condition to terminate a transaction before closing will have to establish an objectively material justification;
• the strict rules governing reporting on profit forecasts, merger benefits statements and asset valuations will apply;
• the rule requiring disclosure of all information provided to a friendly party to a less welcome bona fide competing offeror will apply; and
• the rule restricting the value of break up fees or economically equivalent arrangements to 1% of the Code company's value will apply.

Although the recent changes extend the jurisdiction of the Panel to regulate break fees, it should be noted that the Panel's writ does not run in the period before any offer (including a DLC transaction) is contemplated. The change, which illustrates the hostility of UK institutions to the use of substantial break fees in public deals, has been welcomed by bodies representing institutional shareholders and hailed by the Financial Times as underlining the good health of the UK's flexible approach to the policing of bids.

Copyright © 2002 Gibson, Dunn & Crutcher LLP